Bulletin Number
VTB 05-3
Tax Type
Corporation Income Tax
Description
Financial Corporation Apportionment and Nexus
Topic
Clarification
Date Issued
04-18-2005
TAX BULLETIN 05-3
Virginia Department of Taxation
April 18, 2005
IMPORTANT INFORMATION REGARDING
FINANCIAL CORPORATION APPORTIONMENT
AND NEXUS
FINANCIAL CORPORATION APPORTIONMENT
AND NEXUS
THE DEPARTMENT WILL NOT CHANGE ITS
INTERPRETATION OF NEXUS STANDARDS UNTIL IT HAS
FULLY IMPLEMENTED POLICY CHANGES ATTRIBUTABLE
TO THE VIRGINIA SUPREME COURT DECISION IN
GENERAL MOTORS CORPORATION V. COMMONWEALTH
INTERPRETATION OF NEXUS STANDARDS UNTIL IT HAS
FULLY IMPLEMENTED POLICY CHANGES ATTRIBUTABLE
TO THE VIRGINIA SUPREME COURT DECISION IN
GENERAL MOTORS CORPORATION V. COMMONWEALTH
The Court held that the Department's regulation excluding costs of independent contractors from the apportionment factor of financial corporations was inconsistent with the statute. Because other regulations state that an out-of-state corporation is deemed to have income from Virginia sources if it has a positive apportionment factor, inclusion of independent contractor costs may affect the corporation's nexus with Virginia. Pending a full review of the decision, the Department will not assert that nexus is created solely by costs from the use of independent contractors located in Virginia.
On September 17, 2004, the Supreme Court of Virginia decided General Motors Corporation v. Commonwealth of Virginia, 268 Va. 289, 602 S.E.2d 123 (2004) ("GM Decision"). The Court held that regulation 23 VAC 10-120-250 was inconsistent with Va. Code § 58.1-418 when it limited the costs of performance used to apportion income of a financial corporation to direct costs, excluding costs of independent contractors. The Department stipulated to the amount of such costs that were included in the return filed by General Motors, and the issue of the proper criteria for assigning costs of independent contractors was not before the Court.
The Department is currently reviewing its policies relating to financial corporation apportionment and may amend its regulation or seek legislation to address the issues raised by the GM Decision. Among the policies to be developed are:
· What criteria are to be used to determine the location of an independent contractor's costs? The contracting office of the taxpayer may deal with one office of the independent contractor, while the work is actually performed in various locations around the world. The statute requires a financial corporation to apportion income based on its "cost of performance in the Commonwealth over cost of performance everywhere." Use of an office location to assign costs for apportionment purposes without regard to where the work is actually performed would not be consistent with the spirit of the statute, and would allow taxpayers to manipulate apportionment by their choice of which offices to deal with when the taxpayer and independent contractor have offices in several states. If the financial corporation's apportionment factor must include the costs of its independent contractors based on where the independent contractor performed the work, another issue arises when the taxpayer is unable or unwilling to provide that information.
· What impact will the new policies have on Virginia businesses? The Court's interpretation of Va. Code § 58.1-418 requires that the financial corporation's apportionment factor include any cost of performance related to an independent Virginia business performing contracted services for a financial corporation. When a Virginia business seeks work from an out-of-state financial corporation, its Virginia location may increase the Virginia apportionment factor of the out-of-state financial corporation, and therefore increase its tax liability. Assuming all other factors are equal, the Virginia business may find itself at a competitive disadvantage compared to independent contractors located in other states if, because of this ruling, outof-state financial corporations elect to refrain from contracting with Virginia businesses to avoid increasing their Virginia corporate income tax liability.
· What impact will the new policies have on nexus? Generally, a corporation is deemed to have income from Virginia sources if it has sufficient activity in Virginia to make its apportionment factor positive. Regulation 23 VAC 10-120-20, "Income and deductions from Virginia sources," ¶ A.2.
- Under existing regulations, if an out-of-state financial corporation has no property or employees conducting any activity in Virginia, it would generally not be subject to Virginia tax even though it may have customers in Virginia. The Court's interpretation of Va. Code § 58.1-418 requires that the cost of performance attributed to a Virginia business performing services be included in the apportionment factor. This would make the factor positive, and may subject the financial corporation to Virginia income tax. Assuming all other factors are equal, the Virginia business may find itself at a competitive disadvantage compared to independent contractors located in other states if, because of this ruling, out-of-state financial corporations elect to refrain from contracting with Virginia businesses to avoid increasing their Virginia corporate income tax liability.
Until the Department of Taxation can develop and implement policies that fully address the issues raised by the GM Decision, the Department will apply the following principles to financial corporations:
· At the election of the Taxpayer, the Department will continue to accept returns prepared in accordance with 23 VAC 10-120-250, i.e., excluding costs of performance of independent contractors. The Department will not seek to retroactively impose any new policies developed in response to the GM Decision on returns filed in reliance upon 23 VAC 10-120-250.
· Pending adoption of policies in response to the GM Decision, the Department will not use the Court's interpretation of Va. Code§ 58.1-418 to assert that nexus exists solely because of services performed in Virginia by an independent contractor, or the existence of an office of the independent contractor in Virginia.
· Financial corporations that choose to rely on the GM Decision to ignore 23 VAC 10-120-250 and include costs attributable to independent contractors in their Virginia apportionment factor must disclose the criteria used to determine the location of such costs. The Department may make audit adjustments to such costs if the final policies adopted in response to the GM Decision are retroactive.
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